Goldman, AP to Lawmakers: Keep Spending Like Mad or Economic Growth Will Suffer

Thursday, an odd warning emanated from the halls of the supposedly esteemed investment firm known as Goldman Sachs: If Uncle Sam spends $61 billion less during the second half of the current fiscal year, and ends the year with "only" $3.758 trillion in spending instead of the administration's anticipated $3.819 trillion, economic growth will be seriously harmed.

Yesterday, similar nonsense was put forth by Jeannine Aversa at the Associated Press in reaction to the government's report that economic growth during the fourth quarter was revised down to 2.8% from 3.2%, when experts (like the geniuses at Goldman) had expected the number to come in at 3.3%. The headlined whine: "State and local budget cuts are slowing US economy."

The Republican plan to slash government spending by $61bn in 2011 could reduce US economic growth by 1.5 to 2 percentage points in the second and third quarters of the year, a Goldman Sachs economist has warned.

The note from Alec Phillips, a forecaster based in Washington, was seized in the ongoing US budget fight by Democrats as validating their argument that the legislation approved by the Republican-led House of Representatives last Saturday would do significant damage to the US recovery.

Chuck Schumer, the Democratic senator from New York, said: “This nonpartisan study proves that the House Republicans’ proposal is a recipe for a double-dip recession. Just as the economy is beginning to pick up a little steam, the Republican budget would snuff out any chance of recovery. This analysis puts a dagger through the heart of their ‘cut-and-grow’ fantasy”.

The Goldman analysis also points out that a potential compromise deal with $25bn in spending reductions this year – a more likely scenario – would lead to a smaller drag on growth of 1 percentage point in the second quarter.

The editorialists at Investors Business Daily smelled a rat -- or, actually, dozens of them scurrying through revolving doors (bolds are mine):

... If it were anyone other than Goldman Sachs making the prediction, maybe we'd believe it.

... (Goldman's assertion) is true only if you buy into the Keynesian premise that a $1 increase in government spending leads to a greater than $1 increase in economic output.

That idea has been disproved and roundly criticized after the Obama administration blithely predicted $2.50 in economic activity for every $1 in added government "stimulus."

We've spent trillions more, but have little in the way of growth or jobs to show for it.

... The revolving door between Goldman and government is well-known. An investigative report last year by CBS News counted "at least four dozen former employees, lobbyists or advisers at the highest reaches of power both in Washington and around the world."

They include former Treasury Secretary Henry Paulson, who crafted the stimulus plan and Wall Street bailouts; former Democratic House Majority Leader Dick Gephardt; and former SEC head Arthur Levitt, who as of last year was a paid lobbyist for Goldman.

No surprise, then, that Goldman Sachs would see even the modest cuts proposed by the GOP as a danger to the economy. With its shifting business ties to government, the cuts would certainly be a danger to them.

No one on Wall Street did better as a result of the government's massive, disastrous intervention in the U.S. economy the past two years. Goldman didn't just see its business grow. It also watched as government regulators selectively let some of its key competitors die.

Exactly. IBD also reminds readers that if $61 billion in spending reductions will really harm the economy, $821 billion in stimulus spending should have caused it to take off like a rocket. Of course, that's not what has happened.

Also, there has apparently been no word from Goldman as to the potential effect on economic growth of a few more years of trillion-dollar federal deficits followed by $500 billion-plus deficits as far as the eye can see.

The Associated Press's Aversa tried to sound similar alarms over state and local spending, again without basis. Especially catch the final bolded sentence in the third excerpted paragraph:

Deep spending cuts by state and local governments pose a growing threat to an economy that is already grappling with high unemployment, depressed home prices and the surging cost of oil.

Lawmakers at state capitols and city halls are slashing jobs and programs, arguing that some pain now is better than a lot more later. But the cuts are coming at a price - weaker growth at the national level.

The clearest sign to date was a report Friday on U.S. gross domestic product for the final three months of 2010. The government lowered its growth estimate, pointing to larger-than-expected cuts by state and local governments. The report suggested that worsening state budget problems could hold back the recovery by putting more people out of work and reducing consumer spending.

The report from the Bureau of Economic Analysis "suggested" no such thing. Here's what it did say:

The small fourth-quarter acceleration in real GDP primarily reflected a sharp downturn in imports, an acceleration in PCE, an upturn in residential fixed investment, and an acceleration in exports that were mostly offset by downturns in private inventory investment and in federal government spending, a deceleration in nonresidential fixed investment, and a downturn in state and local government spending.

A different sentence in the report says that "The downward revision to the percent change in real GDP primarily reflected an upward revision to imports and downward revisions to state and local government spending" -- but that's a comment about the degree of January's downward revision, not the overall GDP result.

Table 3 at the BEA's full report shows that compared to the third quarter, on a seasonally adjusted basis, annualized state and local government expenditures fell by $9.1 billion. In a $13.3 trillion economy (in chained 2005 dollars), that isn't even a rounding error. Aversa's alarm has no basis in reality.

More importantly, as IBD noted with federal spending in previously unexcerpted text, studies by Harvard economist Robert Barro and Stanford's John Taylor show that "... more government spending, by taking money out of the private sector, is a loss to the economy and that taking money away from government is a gain." Sure, it may take a quarter or two for offsetting private sector gains to show up in the GDP numbers. But they will show up -- or they will as long as the government doesn't let the leaden hand of overregulation prevent it from happening.

Goldman and the AP's Aversa fail to make anything resembling a case that growth will be held back indefinitely as long as spending reductions continue.

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